Fixed Income Investors Need To Rethink Long Term Treasury Spreads
Take the 10-year Treasury yield for example. If one looks at the 10-year yield minus the 2-year, the average daily spread from June 1976 through today is 87 BPS. The largest daily spread was 291 BPS on February 4th 2011.
The 10-year minus the 2-year spread is too narrow. Fiscal policy is so aggressive that it is a foregone conclusion that the Fed will continue to inflate the money supply to subsidize a portion of each year’s fiscal deficit, not to mention the Fed’s own inflation-driving monetary policy.
Given that inflation of the money supply is essentially a certainty, wouldn’t one want to be compensated more than an extra percentage point for holding the 10-year versus the 2-year?
Today of course the 2-year yield is greater than the 10-year yield as investors believe that short-term yields are coming down soon and that the yield curve will normalize. Maybe so. Yet, given multi-trillion Dollar annual deficits and a $35 Trillion debt load that is growing faster than GDP, wouldn’t one want to enjoy a yield on the 10-year that is at least 10-15% or more? I’m underwater if I own the 10-year now as a 4-5% yield is below real-world price increases that are probably in the 10-20% year-over-year range (ignore CPI - a bogus Government construct of price levels).
At some point a massive recalibration is coming in terms of how investors value the 10-year Treasury.